Which market design best suits the low-carbon transition?

Sep 27, 2016

The European electricity industry is supportive of Europe’s decarbonisation agenda, and is dedicated to decarbonising electricity production by 2050. In the midst of this transition, Europe must ensure secure, sustainable and affordable energy to its citizens and businesses.

With today’s numerous market interventions distorting price formation, the electricity system lacks signals, both for short-term operations, and for longer-term system adequacy and decarbonisation. The market environment has become increasingly volatile and the risk of exposure for investors has risen. In this context, the issues faced by market participants and investors are similar for all assets, be it thermal or renewable generation, storage, or demand response.

EURELECTRIC recently adopted recommendations for an electricity market design that is suitable for a cost-efficient, low-carbon transition. While the power sector faces different fundamentals and regulatory frameworks, market designs are not carved in stone, and should evolve with the transition.

Customers at the centre of the new market design

[Tweet "EURELECTRIC: clear roles and responsibilities for all market players must be defined"]Empowered customers will play a crucial role in addressing the challenges of the energy transition. Integrating increasing shares of variable renewable energy sources (RES) into the system, makes demand response ever more relevant. Technological solutions such as heat pumps, electric vehicles, home management systems, home energy devices, and connected objects will give them unprecedented control over their energy use.

Rules enabling customers’ participation in the market, and ensuring fair competition between all resources (generation, demand response, storage) must be implemented. For this to happen, clear roles and responsibilities for all market players must be defined, including regard for balancing responsibility. Retailers should also be allowed to develop innovative products, such as dynamic pricing, and the phasing out of regulated prices would enhance competition.

Enable markets to function with high shares of renewables

The implementation of the Third Energy Package and the integration of wholesale markets across all timeframes, is the cornerstone of the electricity market design. We must ensure the full integration of day-ahead, intra-day, and balancing markets, and implement shorter gate closure to make the market fit for renewables. Wholesale prices must also be allowed to adequately reflect scarcity, thus, providing trustworthy investment signals. There is also significant scope for more efficient use of electricity transmission networks. ACER’s market monitoring report, 2015, shows that today, in nearly 70% of assessed borders, physical capacity is at least twice as high as tradeable capacity.

Decarbonisation, renewables, and security of supply living up to political targets… in a cost-efficient way!

Given the binding EU objective to achieve at least 27% of RES by 2030, some Member States may continue support schemes after 2020. Many countries also complement their energy markets with a patchwork of capacity mechanisms, to guarantee the security of supply. Unfortunately, non-market-based interventions have also flourished, such as the forbidding of plant closures or the introduction of targeted subsidies, as ill-designed ways of managing security of supply.

Renewables: fully part of the market

In 2014, 56% of the EU’s electricity came from low-carbon sources, and 28% from RES. It is, thus, high time to integrate RES in the market, and to ensure their cost-efficient development. EURELECTRIC does not see any obstacles to the full integration of all RES electricity generators into the market, as of today, including balancing responsibility.

The EU ETS should be the main driver for RES investments in the electricity sector. It is an established, technology-neutral instrument that can bring an increasingly EU-wide approach to low-carbon technologies. If implemented, support schemes should be cost-efficient, minimise distortions in the wholesale market, and be technology-neutral. Auction mechanisms and green certificates improve competition between projects, and set the levels of support in a competitive way. The projects selected through an auction can be granted energy-based or capacity-based support, including investment aid.

Member States must clearly define the level of electricity security of supply they want

Many Member States do not accept the idea of relying on the level of security of supply delivered by energy-only markets, which includes a risk of blackouts. Yet, many of them still do not define clearly their adequacy targets for security of supply. As a first step, they must define this level, using regionally harmonised metrics. Member States should then decide how to ensure regional security of supply with their neighbours, whilst ensuring the availability of contracted cross-border capacity. In case of common scarcity events, TSO actions should be clarified and factored in the adequacy assessment.

Security of supply must be assessed at regional level, with common solutions

To consider the cross-border dimension of the Internal Energy Market, regional adequacy assessments, complementing national assessments, are necessary. To be relevant, the methodology for regional adequacy assessments must be developed with the involvement of all relevant stakeholders, including market players. They should indeed consider the location of generation capacity, along with limited interconnection capacity. The economic viability of power plants must also be taken into account, as it cannot be expected that existing assets remain online, if they do not cover their fixed costs.

In many countries, part of the existing generation capacity is still necessary during the energy transition, to provide firmness to the system, and produce, when intermittent RES do not. Even though these plants are not required to deliver a large amount of energy, they are needed until the moment when storage, smart grids, and increased demand response contribute more to the security of supply. If all these assets closed, they would have to be replaced with new thermal capacity during the transition, which would be very costly. In certain cases, a well-functioning capacity mechanism, remunerating the benefits that these plants bring to the power system, is, therefore, a viable solution.

Capacity markets should be well-designed and have a regional perspective

Regional adequacy assessments should be taken into account, when introducing changes in market design, such as the introduction of market-based capacity mechanisms. Regions that do not consider such developments as necessary, should obviously not be forced to introduce them. On the other hand, the existing initiatives for well-designed capacity markets with cross-border participation, should be considered as building blocks for an efficient regional and European approach.

To minimise the impact on the energy market, these mechanisms should be sufficiently harmonised: they should be technology neutral, open to cross-border participation, open to new and existing generation, storage and demand, and produce outcome contracts with capacity suppliers, which have a lead time and a duration that is consistent with the needs of investment decisions. When such a mechanism is introduced, it becomes a valuable tool for future adequacy analysis, since it provides a market-based assessment of the need for new capacity.